What Default Rates on Subprime Auto Loans Are Telling Us

About 17% of all U.S. consumers are likely to default on a loan payment over the next year, according to a recent report from UBS. More interesting, perhaps, is who these defaulters are.

The UBS Evidence Lab reports that the group’s profile is “middle and upper income, younger, male, urban, and concentrated in the coastal regions.” The UBS researchers also found evidence that defaults on auto loans are likely to spread to more nonprime defaults on credit cards and personal loans.

About 16% of all auto loans outstanding are subprime, amounting to $179 billion out of total auto loans of around $1.07 trillion. Overall subprime debt totals $1.25 trillion in mortgages, student loans and auto loans.

Subprime borrowers (i.e., those with a credit score below 600) have been on investors’ radar screens for at least a year. Now, however, there is evidence that near-prime and prime borrowers are also defaulting more. Some 23% of U.S. banks have forecast an increase in consumer loan delinquencies in 2017, the most in 10 years. And because the banks have been more selective in lending to prime borrowers, it is reasonable to conclude that if high-quality borrowers are about to default, the situation is likely to be worse for subprime borrowers.

The Federal Reserve’s January report on its survey of senior loan officers shows nearly 37% of large banks expect the quality of their credit card loans to deteriorate somewhat in 2017, and just over 38% expect auto loan quality to deteriorate.

The root causes of the rise in delinquency rates can be traced back to rising US consumer income inequality and aggressive easing in lending conditions, primarily from non-bank lenders. In short, central bank reflation efforts have been more successful at fuelling wealth creation for a subset of the consumer and less effective in stimulating broader income growth. Structurally, we have perhaps already saturated credit demand from higher quality borrowers, such as the baby boomer generation. The onus will shift more to younger generations, but this is where our prior UBS Evidence Lab survey highlights the default risk lies.

Among the group profiled by UBS, 55% report income that barely covers or is below expenses, while only 17% report income that significantly covers expenses. That is the 17% most likely to default. However, because about a third of U.S. consumers report no debt, that 17% punches well above its weight, representing about 30% of all consumer debt outstanding.